Corporate bonds made easy
Corporate bonds are one contender, offering less risk as an asset class than stocks and higher returns than term deposits.
So what are corporate bonds?
Corporate bonds are securities, similar to an IOU, that companies issue to borrow money. If you buy a corporate bond, you are lending money to the company that issued the bond.
How do corporate bonds work?
When you invest in corporate bonds, you’re making a loan to the company. This is in contrast to shares, where you are getting an ownership stake in the company.
Most corporate bonds have a face value of $100 when they are issued. The company repays that amount to the holder of the bond at expiry (maturity).
In between issuing the bond and repaying it, the company will make regular interest payments to you, known as “coupon payments” at a predetermined rate.
If you invest $50,000 in bonds that have a coupon of 5%, for example, you will receive $2500 a year in interest payments.
Types of coupon payments
The interest rate is set when the bond is issued and it stays the same until maturity.
The interest rate can go up or down over the term of the bond, according to a formula. This is typically an underlying interest benchmark such as the overnight cash rate plus a set margin.
Indexed bonds are designed to protect against rising inflation. They pay a coupon which rises and fall in line with the Consumer Price Index (CPI).
Like other loans, the level of risk varies significantly between corporate bonds, depending upon the financial strength of the company that issued them.
These can range from strong blue-chip companies which are relatively low-risk to so-called “junk bonds” which are issued by companies that are struggling financially and have a high risk of defaulting.
Generally, the higher the risk associated with a company’s bonds, the higher the interest rate it will pay.
Investors regard bonds as having lower risk than shares in the same company because, in the event of bankruptcy, corporate bondholders have the first claim to any assets the company holds. Shareholders will only receive money if some is left over after debts to other creditors, including bondholders, have been fully paid.
Why invest in corporate bonds?
Investors typically buy corporate bonds because they are seeking a predictable income stream that is higher than a term deposit or a government bond and they are willing to accept some additional risk. Investors also use corporate bonds to diversify their overall portfolio, so it is less exposed to shares.
Pros and Cons of Corporate bonds
- Stable income stream
- Are usually less risky and less volatile than stocks.
- Wide range of issuers and bonds to choose from.
- The corporate bond market is very liquid.
- Lower risk results in a lower return than stocks, on average.
- Corporate bonds expose investors to the risk of company default and also the risk that interest rates on other assets will rise, reducing the value of their bond.
- Most corporate bond can’t be acquired in Australia unless you have $250,000-plus to invest
How do I buy corporate bonds?
You can sometimes buy corporate bonds directly from the company issuing them through a public offer (known as the primary market) at their face value.
You can also buy a limited number of corporate bonds on the Australian Securities Exchange (known as the secondary market) after they have been been issued.
If you have more than $250,000 to invest, you can acquire a portfolio of bonds through some bond brokers.
Corporate bond funds
You can invest in corporate bonds through a bond fund which owns a diverfied portfolio of bonds.
Some bond funds are listed on the ASX and are called Exchange Traded Funds (ETFs).
Alternatives to Corporate Bonds
Investors looking for stable monthly income from corporate bonds, might also want to consider a Residential Mortgage-Backed Securities (RMBS) fund.
RMBS funds are comprised of bonds made up of thousands of home loans.
These RMBS receive regular income from the mortgage repayments of Australian homeowners.
The High Livez fund gives ordinary investors access to an asset class that is usually only available to institutional investors.
Invest as little as $10,000 with zero entry and exit fees.
Find out more about High Livez here.